It was probably the Summer of 1987. In October Wall Street would experience Black Monday, Oliver Stone’s eponymously named movie would be released in December, and ID[idn’t]GAF. I remember slowly turning the dial of the boombox trying to pull the signal in from a distant radio station to hear a Yankees baseball game in rural Virginia; probably from a Washington, DC affiliate. My family didn’t have access to cable or a big satellite dish sitting in the yard like my grandparents next door.
I had wrapped tinfoil around the antenna and had strung-up copper wire in my bedroom. It was my ET moment. It was my Last Star Fighter moment. It didn’t work. Major let down.
Programs from distant markets on the radio were the entry-point to a new world before I could watch one of the 4 channels our rooftop antenna made available. Today we see a similar phenomenon when someone who isn’t from the internet gets exposed to the net’s flattening effects from those that previously held informational advantages.
Several years later while children my age in urban locations were being exposed to N.W.A. and Public Enemy I was hearing Casey Kasum’s Top 40 feature artists like M.C. Hammer and Vanilla Ice. I was fortunate to catch The Fresh Prince and Young MC.
Entertainment experts believe peak nostalgia arrives 20 to 30 years after the time period is originally experienced. For me, this timing also coincides with seeing things through my children’s eyes. Reminiscing about my radio, E.T., and musical experiences are like the mental equivalent of watching Netflix’s Stranger Things. “Look, I remember that!”
With investing, decades often pass as investors and financial services professionals resist moving on from how they began investing. Changing investment products is slow. Sometimes it takes a generation or a traumatic event to cement change. Some of the delays come from avoiding realized capital gains and general apathy or a lack of education on an investors’ part. Other reasons are governmental policies or incentives and compensation structure from those selling the products.
The chart below, as presented in a Ben Carlson blog post, shows who owns assets, but also how certain assets classes have become more or less popular over time. The institutionalization of household assets and the growth of the mutual fund industry and then later ETFs is evident.
This won’t be a comprehensive review of why some of these changes happened or the consequences. For more in-depth coverage head over to this post from Josh Brown. But, here’s the executive summary:
- The success of the First World War fundraising effort led many Americans to their first encounter with investment securities and encouraged speculation in unregulated securities in the 1920s. This period ended in the Great Crash of 1929.
- Investing between The Crash and WWII for the average American was marginal and when utilized was very conservative.
- During the Great Depression, the Federal Government created two Securities Acts and the Investment Company Act of 1940 (The 40 Act) to regulate the financial services industry and to help regain consumer confidence.
- The post-WWII era was characterized generally by prosperity and increasing consumerism as Americans began investing in the market again. Their portfolios were dominated by individual securities; mainly blue chips and treasuries. Assets in the mutual fund industry oscillated based upon general market performance.
- On May 1st, 1975 (May Day) commissions for stock trades became deregulated. Brokers could now compete on price. The self-directed discount brokerage industry, led by Charles Schwab drove commissions lower.
- In an effort to maintain compensation levels many brokers began directing clients towards A-share mutual funds. Commissions were often as high as 5.5% for stock funds. Trailing fees (12B-1) and other share classes of funds would also be created as the competitive landscape changed.
The time period from the 1980s until the tech bubble can be characterized as a golden age for active mutual funds as performance swelled AUM. However, following the 2001 recession investors began shifting fund flows towards indexed mutual funds in response to poor performance, increased appreciation of the importance of costs, and news of conflicts of interest from Wall Streets analysts.
Companies such as Vanguard and Blackrock benefitted with assets surging into the trillions of dollars. The trend continued after the Great Financial crisis as it does today.
There is an evolutionary process in the financial services industry. ETFs are the current product du jour. They have provided investors with greater tax efficiency, drastically reduced expenses, and provided both broad and targeted diversification as the needs dictate. Because ETFs trade like stocks there are still some places where mutual funds are preferable due to the ease of use and sometimes performance such as with bonds.
In the last several years there has been an increasing number of “smart beta” product launches with an ETF wrapper. The funds often use factors (value, momentum, quality, size, etc) that have historically provided outperformance to generate returns in excess of the index which is similar to the objective of an active mutual fund, but with greater tax efficiency.
Investors won’t look back fondly on their previous investments wrappers like a proud participant. “Hey, remember those active mutual fund A shares? They were fantastic, weren’t they?” That isn’t going to happen because the investment landscape continues to be more favorable with each generational transition. Today’s environment is the best ever to be a retail investor and the trend will likely continue. Expense ratios on funds are the new table stakes and performance measurements. Users of the commission-free platform RobinHood probably think they’ve found the best broker for their generation. (Their order flow is being sold to HFTs, but probably no biggie in the grand scheme of things.)
Some of the industry that once earned its nut in asset management is heading towards other business models such as upselling and/or subscription-based financial planning. Investment management and some to be determined level of personal financial planning will be included at little cost to investors. Overall, this seems like a good deal.
However, Wall Street has a history of not clearly stating its compensation or conflicts of interest. One example where the industry is making money in this new environment as revenue from fund management has plummeted is on the paltry interest income investors receive on their cash or sweep account balances. You didn’t know your broker had a side hustle as a banker paying you 15 basis points (0.0015), buying treasuries at +2%, and pocketing the difference? That’s not a bad net interest margin. Welcome to the Upside Down where things resemble reality but are a little off if you look closely.
Relax, we’re saving The Demogorgon description for some form of life insurance that’s not appropriate for anyone ever or an annuity inside of an IRA. This is just a reminder for investors to do due diligence and understand all of their costs and the incentives of those providing services. Just when you think the perfect situation has been achieved remember to check the details and understand the trade-offs.
Many of us look back nostalgically on our childhood memories when life was simpler and allow the feeling of familiarity to warm our souls. That’s ok. But, save your memory of investment traditions for small loses where lessons were learned, stay educated about the changing landscape, and participate in the positive evolution of the industry. Don’t be stuck in the wilderness with an AM radio and a roll of aluminum foil where a broker won’t return your call trying to figure out What’s The Frequency, Kenneth. It’s all static out there.